For the Fed, Wages Trump Jobs

Clowns to the left of me, jokers to the right, here I am -- stuck in the middle with you.

Like Stealers Wheel in the classic '70s song, the market is stuck in the middle heading into Friday's all-important jobs report for June. Economists continue to debate whether the low ISM employment report or the high ADP national employment figure is a more relevant predictor of the Bureau of Labor Statistics' nonfarm payrolls report due at 8:30 a.m. EDT.

The Institute for Supply Management came out with disappointing nonmanufacturing growth for June on Thursday, as retailers reported middling same-store sales. The mixed bag of economic data had the markets stuck again -- between fears that inflation will spin out of control and concerns that the Federal Reserve will be too aggressive in slowing the economy.

Major indices rose Thursday, but volume and conviction were meager. The Dow Jones Industrial Average gained 0.66% to close at 11,225.30, while the S&P 500 inched up 0.25% to close at 1274.08. The Nasdaq Composite gained 0.8% to 2155.09. Up volume was 58% of the 2 billion shares total on the Big Board, while the Nasdaq's 1.7 billion shares were split evenly among up and down volume.

Leading the Dow were shares of Altria ( MO), which soared 6% on news of a Florida Supreme Court decision that reversed the $145 billion punitive damages award levied on the tobacco industry in the Engle case. Other tobacco-related stocks gained on the news as well, including Reynolds American ( RAI), which gained 4.01%, Loews ( LTR), which was up 1.44%, and Vector Group ( VGR), which tacked on 1.59%.

Retailers reporting the strongest same-store sales for June included J.C. Penney ( JCP), which also upped its earnings guidance and added 0.40% to its share price Thursday. Target ( TGT) reported sales in the upper end of its trading range and gained 1.86% on the day.

But it was the economic news that held the markets' attention, as competing jobs reports confounded traders.

Jobs Data Dilemma

The ISM reported Thursday that hiring in the nonmanufacturing segment of the economy was the weakest it has been since January and the second-weakest in the past two years. The survey came in at 57 in June, lower than the expected 59 reading, and down from 60.1 in May. The employment reading fell to 52, from 58 in May. This followed the ISM's manufacturing report on Monday; the employment index came in at 48.7 in June, the lowest reading since October 2003.

The relatively new and untested ADP National Employment Report, released Wednesday, showed exactly the opposite -- a whopping increase of 368,000 jobs added in June. That data surprised investors Wednesday and led several Wall Street firms to increase their forecasts for Friday's BLS payrolls report.

"One of the surveys will come out bruised as an employment indicator," says John Lonski, chief economist at Moody's Investors Service. Consensus estimates for Friday's nonfarm payrolls report have edged up to 200,000 new jobs in June from 160,000 prior to the ADP report.

The ISM report may not be a perfect match for exact employment readings, but its role as an indicator remains intact, writes Tony Crescenzi, chief bond market strategist at Miller Tabak and contributor to RealMoney.com. The ISM report has a much longer history and suggests that even a strong employment showing in June won't last. "ISM data points to weaker growth in the output of goods and services, which will almost certainly result in weaker growth in employment at some point," Crescenzi writes.

The ADP report, on the other hand, has a lot to lose. This is its first market-moving report, and economists' willingness to change their forecasts based on it raises the stakes for the untested report, writes James Bianco, president of Bianco Research LLC. By the same token, it is in part because the ADP data are new and untested that "it brings hope it can offer insight into the non-farm payroll report," writes Bianco.

Advanced Data Processing ( ADP) and Macroeconomic Advisers, which launched the ADP report in May and generated a history for the data going back to the start of 2001, claim a 90% correlation to nonfarm payrolls.

The difference of a few hundred thousand jobs occupies the headlines. But it is the hourly wage portion of the nonfarm payrolls report that will provide more clues to the state of the economy and the Federal Reserve's future plans. The wage picture is not inflationary ... yet. Last month, hourly wages increased only 0.1%, after a higher 0.6% increase in April.

"Containment of labor costs makes it more difficult for retailers to increase prices," says Lonski, adding that the dual pressures of intense global competition for jobs and high productivity levels make it difficult for the hourly wage earner to demand increases.

This creeps into the consumer confidence surveys, which show that workers have low expectations for their income potential going forward. And without expectations for higher wages, many unemployed people drop out of the workforce completely, skewing readings on the tightness of the labor market anyway, says Lonski. The dropout level can be seen by comparing the low 4.6% unemployment rate with the very average 63% workforce utilization rate, or the ratio of employment to the working-age population.

So the headline number for nonfarm payrolls will likely grab attention again Friday, but the wage picture is what the Fed will be watching.

In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click here to send her an email.